It is not just important but necessary to regularly check your business’s financial health. You define certain key performance indicators (KPIs) to measure performance and take corrective actions in business strategy wherever required. It gives you a holistic view of your business operations.
Our expert team of accountants has enlisted such indicators to assess financial performance in various areas of your organization. It will help you analyze and grow your business exponentially.
All Finance and Accounting Outsourcing companies keep this indicator in their mind and assess the performance of an organization.
How is financial performance measured?
Here are the indicators to assess financial performance in various areas of your organization
Gross profit margin
This factor tells you whether the price of your product/goods is fundamentally right or not. Gross profit margin is basically the overall profit you gain without covering up all the fixed
operations costs. Hence, better margins equal better profits.
Here’s the simple formula to calculate Gross profit margin:
Gross profit margin = (revenue – the cost of goods sold)/Revenue
Sounds like the primary reason for your business. Doesn’t it? This is what you have ultimately after paying all your bills. Simply put, deduct your total expenses from the total revenue to calculate your net profit.
Let’s assume, your total billing is $2, 00,000 and your monthly rent, employee salaries, and other fixed cost expense collectively add up to $1, 20,000. Your net profit is $80,000.
Debt asset ratio
The Debt asset ratio is your assets financed with debt. It is, in other words, telling you the financial leverage used in your business.
The higher ratio indicates financial risk, so as a business owner, you should have the proper mix of shareholders’ funds and debt wisely. This is a critical KPI to determine the credibility of your business in the eyes of investors as well as customers.
It is the capital; a business needs to run its day-to-day activities. Working capital is basically the liquidity available for ongoing business operations.
Working capital = Current assets – Current liabilities
The optimum level of working capital helps in attaining better operational efficiency. This indicator suggests you keep enough positive difference between current assets (accounts receivable, cash, etc.) and current liabilities (accounts payable, provisions etc.) for smooth business operations.
Operating cash flow
It is essentially the amount of cash that your business produces through your regular business operations such as Sales, purchases etc. It is important that your business operations generate sufficient cash flow to be more financially independent.
Operating Cash Flow (OCF) = Operating Income (revenue – the cost of sales) + Depreciation – Taxes +/- Change in Working Capital
Positive cash flow indicates a promising future and negative cash flow signifies raising additional capital or debt in your business.
Return on equity
Return on equity (ROE) is the measurement of a company’s profitability. It represents the rate of returns, stockholders receive from their investments. It indicates the financial performance of a company in relation to shareholders’ money.
ROE = Net Income or Profits/Shareholder’s Equity
A good ROE brings trust among shareholders and attracts other investors.
Debt to equity ratio
The debt to equity ratio is an important KPI to determine the financial accountability of your business. It is calculated looking at your total liabilities against equity.
Debt to equity = Total liabilities/Total equity
It gives you a better understanding of your capital structure. It is basically the financial leverage ratio to measure your company’s ability to meet short and long term obligations.
As the name suggests, the Quick ratio is the fastest way of assessing a company’s financial position. It is the company’s current ability to pay off liabilities and debts with readily available liquid assets.
It is also known as the “Acid test”. It shows the financial performance and flexibility of your company.
There is a non-stop inventory flow in and out of your warehouses. Inventory turnover represents the number of times, your company sells and replaces inventory in a specific time period.
Inventory turnover = Cost of inventory sold/Average inventory value
It ensures that you don’t have excessive inventory compared to your sales. It gives you vital details of your sales and production planning for better efficiency of operations.
Accounts payable turnover
Accounts payable turnover is the rate at which your business pays to its suppliers. This is an interesting KPI to figure out and prepare cash flow as well as find flow planning.
Accounts payable turnover = Total suppliers purchases/Average accounts payable
If the ratio declines, it indicates a decrease in payment frequency to suppliers which is a negative sign of financial position. Delay in payments could deprive you of vendors’ early payment discounts.
Accounts receivable turnover
Accounts receivable turnover indicates the rate at which your business collects due payments. This KPI ensures that you receive funds in a timely manner which is extremely crucial for your business. This KPI helps in cash flow planning, determining credit policy, and sales discount policy.
Accounts receivable turnover = Sales/Average accounts receivable
It evaluates your credit policy, a high turnover suggests an aggressive collection policy and a low turnover suggests inadequate inflow of funds.
Evaluating financial performance is an essential part of any business. It will significantly contribute to your long-term success. We hope these 11 financial KPIs help you measure your business growth as well as prepare budgets and business strategy. For any financial queries or consultation, CapActix would be happy to assist. Write to us at [email protected]. or call us at +1 201-778-0509.